Central & Eastern Europe April 2018

Central & Eastern Europe: Economic growth continues to roar on, despite tense political backdrop

March 7, 2018

A complete batch of GDP data confirmed that the Central and Eastern European (CEE) economy continued to enjoy rapid growth in the final quarter of 2017. A comprehensive estimate revealed that regional GDP expanded 5.0% annually in Q4 2017, a notch above last month’s estimate. The reading was slightly below the third quarter’s 5.2% increase but still marked one of the best performances of the last decade. The CEE economy has enjoyed a buoyant growth spell over the past year on the back of strong demand from the Eurozone, a major trading partner; booming investment; tight labor markets; accommodative monetary policy and fiscal stimulus in the region.


The upward revision to the region’s fourth-quarter growth rate was due to revised national accounts data for the Czech Republic. More complete data for the country revealed that government spending gained steam in the quarter. This, combined with robust investment on the back of higher absorption of EU funds and healthy household spending amid a tight labor market, caused GDP to expand at the quickest pace since Q3 2015. Elsewhere in the region, the growth picture was also sunny. Buoyant domestic demand fueled Poland’s economy to grow at the fastest pace in six years in Q4, and salary hikes, low unemployment and soaring public consumption caused Hungary’s economy to expand at the quickest pace since Q2 2014.


Available economic indicators for the first quarter of 2018 suggest that the CEE economy continued to enjoy robust momentum, with many of the drivers of last year’s strong growth still in place. Retail sales figures for January and February point to strong household consumption, likely driving by rising wages and low unemployment. Accommodative monetary policy and positive business sentiment should be supporting investment. Regional GDP is forecast to have grown a healthy, but slower, 4.4% in the first quarter of 2018.


The region’s political situation has been dominated by clashes with EU officials over policy in the past year, particularly on measures that are seen as backsliding on democracy and migrants. Poland has been embroiled in a standoff over controversial judicial reforms for two years, which saw the European Commission invoke Article 7 of the EU Treaty against it last December, an unprecedented disciplinary move. In March, the Polish government offered some policy concessions, and in April representatives from both sides of the conflict met for negotiations. It remains to be seen, however, if the changes to the judiciary were sufficient to address the EU’s concerns over the rule of law.


Hungary appears set to continue clashing with EU officials and other member nations after Prime Minister Viktor Orbán and his ruling Fidesz party won a supermajority in the 8 April general elections. The large parliamentary support will allow Orbán to potentially push through wide-reaching reforms, and he campaigned on a staunchly anti-immigration platform. Furthermore, the European Commission and the European Parliament have voiced concerns over recent judicial reforms in Romania, which could undermine judicial independence.


Meanwhile, political uncertainty has risen notably in the Czech Republic and Slovakia in recent weeks. In the Czech Republic, the Social Democrats pulled out of coalition discussions with ANO on 6 April, generating uncertainty over the next steps to form a government and increasing the risk that the country could head to a snap election. A cabinet reshuffle has failed to ease political tension in Slovakia after the murder of a journalist investigating corruption and his fiancé provoked widespread protests across the county. 


Economic prospects upgraded for fifth consecutive month


Despite some political uncertainty in the region, the CEE economy is expected to continue enjoying a robust growth spell as the majority of last year’s tailwinds remain in place. The Eurozone’s economy is expected to grow at a healthy rate this year, supporting the CEE region’s exports. Tight labor markets and solid absorption of EU funds should support household consumption and investment. That said, growth is expected to decelerate from last year’s over one-decade high as inflation creeps up and the impact from some fiscal stimulus measures fades. FocusEconomics expects regional growth to come in at 3.9% this year, up a notch from last month’s estimate. Next year, growth is projected to slow to 3.3%.


This month’s upgraded 2018 outlook is due to upward revisions for 4 of the 11 economies included in the region, including major players Hungary and Poland. The forecasts for the remaining seven economies were left unchanged.


Romania is projected to be the fastest-growing economy this year, with GDP seen expanding 4.5%. Poland and Slovenia are also seen achieving fast growth rates this year of above 4.0%. On the other end of the spectrum, Croatia is projected to be the region’s laggard, with an expansion of 2.8%.


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POLAND | Positive economic data flows in


According to available data, last year’s economic momentum carried over into the first quarter of this year. Consumer spending likely continued to drive the expansion, as suggested by buoyant growth in retail sales in both January and February. Moreover, tight labor market conditions and robust wage increases in the first two months of the year show that labor market dynamics remain growth-supportive. A healthy labor market together with rising tax revenues were behind the sizeable budget surplus recorded in January. Good news also came from the production side of the economy: Industrial production expanded robustly, and construction output surged in the January–February period. Furthermore, the PMI reading shows that the manufacturing sector continued to grow healthily in March, while sky-high business confidence indicates solid growth in economic activity going forward.


Strong domestic demand will drive growth this year. Rising EU funds inflows, buoyant construction activity and upbeat business sentiment are expected to buttress fixed investment, while strong wage and employment growth will underpin consumer spending. External demand should nonetheless moderate, and expansionary fiscal policies ahead of local elections in autumn and parliamentary elections next year will lead to a widening budget deficit. FocusEconomics panelists expect GDP to expand 4.1% in 2018, up 0.1 percentage points from last month’s forecast, and 3.4% in 2019.


CZECH REPUBLIC | Political uncertainty escalates after CSSD pulls out of coalition talks


Talks between the ANO party and the Social Democrats (CSSD) collapsed on 5 April, reportedly over the ANO’s refusal to give up the Interior Ministry. Prime Minister Andrej Babis is scheduled to meet with President Milos Zeman on 10 April, to determine if snap elections will be called. While Babis opposes snap elections, they likely would not result in a significantly different outcome from the previous vote. Opposition forces, most notably the Civic Democrats, are arguing that it is now time for another party to take the lead in the process of forming a government. Contrasting the political uncertainty, news about the economy has been good. A revision to the 2017 GDP result showed that the economy grew at a slightly quicker pace than previously reported. Last year’s strong momentum likely carried over into Q1: Industrial production and retail sales picked up pace in January, while the PMI remained elevated during the quarter, despite moderating slightly, and consumer confidence edged up.


Political turmoil remains the biggest short-term risk to the economy, while Babis’ legal troubles also continue to pose a risk. Nonetheless, this year, the economy is expected to grow robustly on the back of solid public and private consumption. Moreover, a major downside risk could dissipate if a bill safeguarding against a potential exit from the EU passes parliament. Consensus Forecast panelists see GDP growing 3.4% in 2018, which is unchanged from last month’s projection, and 2.9% in 2019.


ROMANIA | Leading data points to solid momentum in Q1


A third estimate confirmed that GDP growth cooled somewhat in the final quarter of 2017, although it remained strong. Economic activity continued to expand robustly in Q1, according to available data. Industrial production increased notably in January on the back of strong performances of export-oriented sub-sectors such as machinery and equipment and automotive industries. In the first two months of the year, the unemployment rate dipped to a multi-year low and retail sales expanded healthily, suggesting that consumer spending remains buoyant. In the political arena, the Senate approved a reform package to overhaul the judiciary, despite recent warnings from the EU that this could undermine judicial independence. The law will now have to be signed by President Klaus Iohannis and parliamentary opposition announced it will challenge the law before the Constitutional Court. If eventually adopted, it could spark massive protests and undermine investor confidence.


Growth is expected to slow but remain robust this year, as the expansion in consumer spending is restrained by higher inflation and a moderation in wage gains. Rising inflows of EU funds will speed up growth in fixed investment. However, imbalances are building up in the economy, as expansionary and pro-cyclical fiscal policies are leading to growing capacity constraints and a widening in budget deficit, posing risks to economic stability. Moreover, high external debt and the sizeable current account deficit leave the country exposed to external shocks. FocusEconomics panelists expect growth of 4.5% for 2018, unchanged from last month’s forecast. They see the e


HUNGARY | Orbán remains at the helm, ensuring economic policy continuity


Current Prime Minister Viktor Orbán secured his fourth term after obtaining a landslide victory in the 8 April general elections. The Fidesz-KDNP alliance won 134 seats in the 199-seat unicameral parliament and secured a two-thirds supermajority. A supermajority enables the incumbent prime minister to pass sweeping reforms in the county’s economic and political institutions and tighten his grip on power without many restraints. Orbán  will oversee an economy that is firing on all cylinders. Revised national account data confirmed that economic growth reached a multi-year high in Q4 and the latest data from the first quarter remains positive: industrial production and retail sales expanded robustly in January and February, and survey-based consumer and business confidence was positive throughout Q1, boding well for growth in both private consumption and fixed investment.


Robust external demand, accommodative monetary policy, and disbursement of EU investment funds will keep the economy on a solid growth trajectory. FocusEconomics panelists raised their projections this month by 0.1 percentage points and see the economy expanding 3.7% in 2018. For 2019, the panel sees growth slowing to 3.0%.


MONETARY SECTOR | Inflation falls in February


According to an estimate produced by FocusEconomics, inflationary pressures in the region moderated in February. Inflation fell from 2.4% in January to 2.1%, which marked the lowest reading since August 2017. Softer price pressures were recorded in most countries, including the Czech Republic, Hungary and Poland. A preliminary estimate for March suggests that inflation remained at 2.1%.


Still-contained inflationary pressures allowed most central banks in the region to hold policy rates unchanged in recent weeks. Policymakers in the Czech Republic, Hungary, Poland and Romania all left rates stable. In Romania, however, the decision to hold rates surprised market analysts, as inflation has been above the Central Bank’s target in recent months. However, the Bank stated that more time was needed to see earlier rate hikes fully transmitted to the economy, and it expects inflation to stabilize in the coming months.


Inflation is seen rising this year after averaging 2.0% in 2017. Higher commodities prices and buoyant economic momentum will fuel slightly higher price pressures. Inflation is expected to average 2.5% this year, unchanged from last month’s forecast. In 2019, inflation is seen stable at 2.5%.


 


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Angela Bouzanis


Senior Economist 


 

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